You perform your best in school, you study diligently at university, get a great job, work industriously throughout your career all so that one day you can kick back and enjoy a nice pleasant retirement.
That’s the story anyway. It’s how I was brought up to think. But it’s not a story that always lives up to reality. There are countless stories of people with good jobs, and diligent savings patterns still needing to work well into their twilight years. This is to say nothing of people that unfortunately never have the privileges of higher education or a stable career.
Recent reports have found that less than 30% of American workers are on track to retire at all, and even fewer think they will have a comfortable retirement, and they might be right.
I know most people don’t want to hear this, but there are a few BIG factors at play in the world today that are going to act to keep most younger generations in the workforce indefinitely.
This is all before considering the major impact that the COVID-19 pandemic has had. This global event has actually worked to widen the gap between younger generations with fewer assets and more precarious employment, versus older generations which tend to be more secure.
Now you might think you are different, you contribute to your 401k, save diligently, subscribe to EarnYourSix and even invest regularly into the stock market.
Well that’s all great, but I might still have some bad news for you.
There are lot’s of issues at play here.
Housing
The stock market and a series of broader economic conditions might threaten the general assumptions we make about indefinite growth. So it’s time to learn how money works to find out why we will all be on that grind until we are 120 years old.
So the obvious first culprit is housing. Affording a home has become a major challenge for most workers in the USA. I know this problem is nothing new, but there ARE still a few very important factors that people don’t consider. Even very high-income earners that graduate top universities and go into fields like banking or big tech tend to be moving to equally high cost of living areas like New York, Chicago, or San Francisco.
Pew Research recently reported that a majority of young adults between the ages of 18 and 30 are now living at home with their parents. The median age of a first home buyer in 2019 was a 34 and experts agree it’s almost inevitable that that figure will be pushed even higher by the pandemic.
What’s more is that young buyers tend to be purchasing smaller dwellings like apartments and townhouses rather than traditional free standing family homes. This is not because they don’t want to, but because they can’t afford it. This is a real issue because as most financially secure people will tell you their house is their biggest asset. This doesn’t just mean it’s the asset that they own that’s worth the most money either.
Owning a house means that you don’t have rental expenses and even if you are paying a mortgage those payments will at least partially be building equity in the home itself. Additionally, once that mortgage is paid off you have somewhere to live with very little ongoing costs.
Retiring with a home, means that even modest retirement savings or a pension can go a very long way when compared to someone who will need to stretch those payments to cover rent. If a homeowner is running low on cash in retirement it could be a simple as downsizing their family home, a luxury not possible for someone who hasn’t fully paid off their home, or doesn’t own one at all.
Now let’s be generous and take this median age of 34 to buy a first home, stick a 30 year mortgage on top of it, and suddenly even this generous assumption of a regular young worker is in their mid 60’s still paying off a home loan. This is assuming that this person never upgrades their home, or renovates, or does anything to increase their mortgage from the original one they take out over thirty years.
The particularly morbid amongst you might think, well the boomers have to die and leave us their homes eventually right?
I guess so; as unpleasant as that may be, it is a reality.
The problem is this will likely only exacerbate the issue. We saw this in our post on why family fortunes disappear; inheritance’s that could actually fund a retirement tend to go to people that are already pretty old and wealthy themselves.
Now again the unaffordable housing issue is a debate as old as modern capitalism, but maybe this isn’t an issue anyway, maybe you are still unconcerned because you have plans to fund your retirement even without a house to call you own.
Let’s put those plans to the test.
The stock market is the other major vehicle by which people fund their retirement. Even fixed income pension funds ultimately rely on the growth of these markets to provide incomes to their members in retirement, but this assumption of endless returns may be under threat.
To understand why consider a simple example.
10 lumberjacks are working at a sawmill that creates frames for residential homes. At the moment the lumberjacks are only using basic hand tools, but if they all work hard and nobody slacks off they will meet their quotas.
One particularly astute lumberjack takes a portion of his pay cheque and over time uses it to fund research into motorized tool’s. His money was well spent because he eventually invents the table saw. He then saves up a bit more of his money to buy the materials needed to built 9 copies of his new contraption. He then gives these 9 table saws to his colleagues who had previously been using those hand tools.
This boosts their productivity enough that they can still meet their quota even if the first lumberjack doesn’t show up to work at all.
This is what we call capital investment, and it’s how (at least in theory) we can sustainably fund peoples retirements.
The same amount of frames are made, the other 9 lumberjacks don’t need to work longer and harder, and the first lumberjack has been properly rewarded for his creation with a nice cushy retirement.
Of course this is a very crude example but in reality most people do the same thing by investing in the stock market. Companies raise money and then use that money to purchase capital equipment, which will allow their worker to effectively and efficiently produce goods and services for the economy.
But lets go back to our example.
Problems start to arise when more of these “lumberjacks” get the same bright idea. One might invest into a forklift to make the work of nine men possible with just eight, and then another might do the same with nail guns to make the work of the remaining 8 men possible with just 7 and so on.
Every time this happens it get’s a fair bit harder to find that next thing. Eventually you are going to need an almost fully automated production line and even then you are probably going to want at least one worker there to oversee this operation.
Every human you take out of the equation and replace with a piece of capital becomes more and more expensive, especially when compared to some other alternative investments.
Let’s say lumberjack #5 will need to invest Millions of dollars into a robotic arm in order to effectively retire while still ensuring the quota of the lumbermill is met. He might just say, “what I’ll do instead is just buy the factory and require the remaining four workers to work an extra 10 hours a week to pick up my slack while I go and retire.”
Now this guy sounds like a jerk, but just think, how many hours a week are you working in your job just to cover your rent?
This investment into non-productive assets (as in assets that don’t actually assist in adding value) is a major hurdle.
Now the classic example of a non-productive asset is something like gold, bitcoins, pokemon cards and of course real estate. Although real estate is weird, because unlike these other non-productive assets it does produce income without needing to be sold; it does this through rent.
Investing into real estate has been a particularly attractive investment for a lot of people which does two things. 1) it increases the price of real estate, causing more of the issues we saw in another post, but 2) it takes away from investments into the types of productive assets that CAN sustainably fund retirements.
There is one other problem beyond this as well: over-inflation of ALL asset markets.
Let’s look at our original example of those table saws.
They were machines that made cut up pieces of wood, lets say they can chop up 20 pieces each a day. Now let’s replace those table saws with shares, these are effectively machines for making money in the form of dividends. Lets say each share makes 20 dollars a day. In both examples the lumberjack would need to own 9 of each to be able to fund their retirement, 180 pieces of wood would replace their job at the lumber mill, and $180 a day would replace their income, so either works just fine.
Counterintuitively, problems arise when these assets become more expensive.
Most people think stocks getting more expensive is a good thing, and it is for the people that already own them (That’s why I’m always promoting to get in on the investment boat today, if you haven’t done so already).
Imagine each share was trading for $10,000. Saving up $90,000 is a pretty tall order for a lumberjack on $180 per day but it is certainly possible over a working career.
Now, imagine those same shares were trading for $100,000 while still paying the same $20 daily dividend.
If you already owned these shares you would be feeling great because your on paper net worth (or equity) has grown handsomely, but our lumberjack now has to buy $900,000 worth of shares to fund his retirement, which is just not realistically possible within his working career.
Now this might sound like a farfetched example but it isn’t! it’s exactly what is happening today.
To see this let’s look at the price to earning’s ratio (P/E ratio) of the s&p 500 (a collection of the 500 largest public companies in America). Historically it has hovered around a multiple of 15x, this means that on average it would take the earning on these shares 15 years to pay for the share itself. Today, that multiple is sitting just under 50 years, which is the second highest it’s been in history, falling only behind late 2008, which as you all know was a time of widespread economic prosperity.
This means people are going to either need to invest 3x as much to fund their retirement’s or rely on the next biggest “fool” to buy their shares off them in retirement for a 100 times multiple, 200 times multiple, 1,000 time multiple, and so on, which, by the way, certain investors are already doing for some stocks.
Now you might say, oh well shares aren’t like table saws with fixed outputs. These dividends can and likely will increase in the future, right?
Sure, that’s almost guaranteed, but it’s still unlikely we will ever see widespread PE ratio’s under 20 again for 2 reasons.
- If a company starts paying out a consistently high dividend relative to it’s market price, investors will buy it which will push up the price, meaning that it won’t be a great deal anymore. Market forces don’t like to play nicely.
- Robert J Gordan is an American economist who published this paper with the National Bureau of Economic Research Is US Economic Growth Over? Faltering Innovation Confronts The Six Headwinds. It’s a fantastic paper that is surprisingly readable even to people without a strong economic background. Gordon basically argues that the past 200 years of innovation and economic growth were more or a exception rather than the rule that we should continue to expect indefinitely into the future. Limitless growth in a finite world? You do the math. Gordon basically argues that this generation is the 5th lumberjack; all the easy innovations that drastically improve productivity have already been made, and even gradual improvements from here on out will either be very expensive, or just rent seeking in nature, working more to shift value around in new and creative way’s more so than working to actually create value.
If this rather bleak outlook wasn’t enough Gordan argued that this would coincide with what he described as the 6 economic headwinds. These are forces that will act to slow growth in economies around the world for at least the next 100 years.
These headwinds are:
a) The loss of the demographic dividend
Basically the economy saw a huge boost when women started to move into the workforce between the 1960’s and the 1990’s.
Now most women in developed countries work a professional career similar to their male counterparts but that’s just the status quo now. We aren’t ever going to be able to double the workforce again, unless we make people work later and later in their lives.
b) The loss in educational attainment particularly in the USA.
Education is becoming more expensive, less comprehensive and increasingly irrelevant to the requirements of the modern work force. A 3 year degree simply does not mean as much as it did 50 years ago, not to an individual or to the economy as a whole.
c) Rising inequality
A touchy subject at the best of times, but Gordan was surprisingly pragmatic about his approach to the issue. The paper noted that incomes were on average increasing by around 1.3 percent per year. But growth was heavily focused in the top 1%, the remaining 99% only actually saw income growth of around 0.75% year over year – not even enough to keep up with inflation.
That means that if this trend continues it will be inevitable that larger and larger pools of workers simply won’t have the financial means to save for retirement.
However if you are in the top 1% congratulations! you can say this post title is wrong in the comments section.
d) The impact of globalisation
Now in theory globalisation should make everybody wealthier, and on “average” it does, but averages have outliers, and those outliers in this case will be national workforces that have historically enjoyed high incomes relative to the rest of the world, like probably you watching.
The other side of this equation is that globalisation “should” equalise global wages, meaning it is great for people in countries that have typically had low incomes compared to the global average, oh and of course the business owners that can profit from the pools of cheap labor along the way.
e) Energy and the environment
The growth of the past century was driven by fossil fuels, a cheap, easily transportable incredibly efficient source of energy that could power everything from automobiles to jetliners. But of course they are a finite resource that have come at a cost. This cost will now be paid by younger generations either in the form of environmental regulations that slow down industrial output, or from complete environmental collapse that will also slow down production.
f) Debt
Household debt, government debt, corporate debt, it’s all been growing steadily over the years and eventually this needs to be paid back, this is ultimately going to result in the requirement for more income or less spending. For the government producing more income is easy, they can “just” tax more, but for individuals and businesses the only option they might have is spending less.
If someone is already running on a tight budget then those regular contributions to a retirement account might be what ends up getting sacrificed.
Gordon did present a likely outcome to alleviate this sixth issue for all parties, and you might be able to guess what it is. Yeah, push back retirement ages.
Now if this has all been a bit bleak for you and you still think you are going to make millions overnight then good on you, I will have to work harder at crushing your spirit next time. But until then you should learn what to do with your overnight windfall by reading our other blog post on exactly what you should do if you suddenly make a lot of money.
Of course step one will always be to share this post and subscribe to keep on learning how to EarnYourSix.
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